On 28 July 2016 the European Commission endorsed, with amendments, the draft rules on margin requirements for non-cleared OTC derivatives contracts (“Margin RTS”). The margin rules are designed to prevent the build-up of uncollateralised exposures by requiring certain counterparties to post initial margin and variation margin.
The date on which counterparties will be required to comply with the margin rules will depend on the aggregate notional amount of non-centrally cleared derivatives trades that have been entered into, with the application of the margin rules determined as at the “date of inception” of the derivatives contract (please see our previous alert for further details).
The Commission amendments relate to certain technical matters which:
- outline the rationale for delaying the application of the margin rules to single stock equity options and equity index options by 3 years;
- confirm that cash initial margin can also be held with non-EU credit institutions where an equivalence decision has been issued by the European Commission;
- clarify that the application of the margin rules to FX forwards will apply from the date specified in the delegated act under the Markets in Financial Instruments Directive II, or 31 December 2018, whichever is earlier; and
- amend the concentration limits for pension scheme arrangements - concentration limits restrict the proportion of specific forms of collateral, to promote diversification and reduce risk.
The Commission has also clarified in the Margin RTS that counterparties may apply to or notify their member state regulator for the intra-group exemption once the margin rules have entered into force (i.e. 20 days following publication in the EU Official Journal). An application or notification will have to be submitted where: (a) the counterparties are located in different EU member states, or (b) one counterparty to the derivatives trade is established in a "third country" and the other is established in an EU member state. The exemption will only be granted if certain conditions are met (the conditions that apply will depend on how the counterparty is categorised). If the exemption is granted then the counterparty will either be wholly or partially exempt from the margin requirements. The relevant counterparty must publicly disclose details relating to its reliance on the exemption.
There is a temporary three year reprieve for intra-group derivatives transactions between an EU counterparty and a third country entity without the need for an equivalence decision by the Commission in respect of the third country (provided that all the other conditions of the intra-group exemption are met). This three year reprieve will be cut short if the Commission subsequently makes an equivalence decision for the third country prior to the end of the three year period.
It is critical that counterparties understand whether they meet the requirements to qualify for the intragroup exemption from the margin requirements and that they submit the application to the relevant member state regulator using the relevant final application form.
We note that the FCA has published a draft application form for the intragroup exemption pending finalisation of the Margin RTS to give counterparties an idea of the types of questions they will be asked and the information that they will be required to submit in order to give counterparties more time to prepare their applications. The FCA is expected to publish the finalised application form shortly.
The application or notification must be completed on a per counterparty basis, and may cover all the intragroup OTC derivative contracts falling within the intragroup exemption, provided that the information is clearly provided per counterparty.
The European Commission has also proposed an adjusted timetable for implementation of the margin rules as follows:
- the variation margin rules to apply: (a) to the most active qualifying counterparties from one month following the entry into force of the margin rules; and (b) from 1 March 2017 for all other qualifying counterparties or one month following the entry into force of the margin rules (whichever is the latest);
- the initial margin rules will be phased in from 1 September 2017 for the most active counterparties and then will apply to other qualifying counterparties from 1 September each year (i.e. 2018, 2019, 2020) depending on whether their trading activity exceeds the relevant threshold.
Third country regulated markets
The European Commission has declared certain US designated contract markets to be equivalent to EU regulated markets. This means that derivatives trades that are entered into on such markets will no longer be treated as OTC for EMIR purposes. Counterparties will not be subject to the risk mitigation obligations (e.g. confirmations, portfolio reconciliation, dispute resolution, margin etc.) or the central clearing obligation in EMIR.
Derivatives Clearing involving Category 3 Firms
There have been three clearing mandates determinations approved by the European Commission so far. The date from which counterparties must comply with the mandatory clearing obligation under EMIR will depend on which of the four categories the counterparty falls into (please see our previous alert for further details).
On 13 July 2016, the European Securities and Markets Authority (ESMA) published a consultation paper that proposes to postpone the phase-in date for central clearing of OTC derivatives contracts entered into with a Category 3 counterparty for three years. Category 3 counterparties consist of financial counterparties and alternative investment funds (please see our earlier link on counterparty categorisation) whose aggregate month-end average outstanding gross notional amount of all non-centrally cleared derivatives over the relevant three month period does not exceed Euro 8 billion. The consultation closes on 5 September 2016 and ESMA is expected to publish its final report by the end of 2016.